Watch out, because you might just see a bump in your personal credit score on the way. That’s because thanks to Experian, TransUnion, and Equifax—the three major credit bureaus—credit reports no longer include tax liens. The change went into effect April 16, so it’s a brand new policy, and it could impact millions of Americans—especially small business owners who need stronger credit to apply for a business loan.
The exclusion of tax liens from consumer credit reports is the next installment in a series of changes in the way credit bureaus report personal credit scores. In March 2015, the three major credit bureaus together launched the National Consumer Assistance Plan (NCAP) to implement industry-wide policy changes to “make credit reports more accurate.” As a result, the credit bureaus removed all civil judgments and the majority of tax liens from consumers’ credit reports last July. And now, they’re eliminating the rest of those tax liens.
Credit bureaus calculate your personal credit score using data from your credit report, quantifying it on a scale from 300 to 850. In their calculations, the credit bureaus consider information like the amount of debt you owe, the types of credit you have, and the timeliness of your loan payments. Although you start at 850, mistakes ding you—and there are many ways to lower your credit score. In particular, the three types of public record data that can appear on your credit report—bankruptcy, civil judgments, and tax liens—can cause major damage to your credit score.
Now that personal credit reports now longer include tax liens, this can help boost scores for anyone who needs help securing better financing products. The change, which can add potentially needed points points on a credit score, could be big news for people seeking small business loans or business credit cards especially.
Since financial institutions—small business lenders and business credit card issuers—only want to work with the borrowers who they think they will repay back their debt, they’ll look closely at your credit score. Your credit score is a numerical track record of how well or poorly you’ve managed your financial obligations over the years. Those who’ve been hit with a tax lien will no longer need to worry about its impact on their individual credit scores. (Although, just to be clear, the tax lien itself won’t go away.)
The government places tax liens on people who neglect or refuse to pay their taxes in full and on time. You can find yourself with a tax lien due to failure to pay any kind of taxes, including state and business taxes. In this public document, the government asserts that it has first dibs to seize the individual’s assets in order to recoup their missing debt. Any asset that can be seized and liquidated is fair game, including inventory, real estate, and intellectual property.
Again, liens are public data—which means that everyone, including potential lenders, can see its existence on an individual’s record.
JD Reichenbach, a loan specialist at Fundera, adds, “A tax lien indicates to a lender that you’re a ‘risky’ borrower, because it means you can’t service the debt you have on the books correctly. Many lenders won’t extend loans to people with tax liens in place, because those borrowers need to pay the lien before they can pay the debt they owe a lender—and lenders are they’re concerned that they won’t be able to manage all those finances properly.”
Essentially, liens are turn offs for lenders, because they want to be the first in line—what’s called the first “lien position”—to seize a potential borrower’s collateral in case that borrower defaults on their loan.
But with a tax lien in place, the lender is automatically bumped down a notch behind the government—which means that the lender might not be guaranteed collateral at all. And since lenders are trying to mitigate risk at every turn, they may entirely turn down a loan applicant with a tax lien in place.
Due to NCAP’s credit report adjustments, however, lenders will no longer see tax liens on applicants’ credit reports, and the impact of a tax lien will no longer lower your credit score.
But according to LexisNexis Risk Solutions, only 11% of consumers have liens or civil judgments on their credit reports. The data also shows that removing liens and judgments results in an average increase of 10 points on credit scores. However, some credit scores might increase as much as 30 points. If this affects you, you’ll see the increase next month.
So, if you had a tax lien on your credit report, its removal may or may not increase your personal credit score enough to bump you up to the next credit score bracket. But if it does, that increase may be enough to qualify you for loans which you would have previously been shut out of. “Personal credit score is a huge factor in small business loan applications,” Reichenbach says. “So if your score jumps with a lien being released, you could have even more loan options available to you.”
Even if you won’t have a lien removed from your credit report, this policy change will impact the way lenders assess potential borrowers across the board.
Without that public record data, lenders have fewer factors by which to gauge how well or poorly a borrower will be able to pay them back, and how trustworthy they are with their debts in general. Basically, lenders won’t be as able to differentiate high-risk borrowers from low-risk borrowers. So to weed out those hidden, risky borrowers, lenders might have to hike up their interest rates on all their loans.
Ultimately, if you previously had a tax lien on your credit score, you’ll have to check your credit report to see the exact impact of its removal. But even if you haven’t had a tax lien on your report, you still might experience the effects of the new credit reporting policy the next time a lender assigns you an interest rate on your small business loan.